Market Model
Supply and Demand
Markets
Institutions that allow buyers and
sellers to exchange
 Demand
 Supply
Examples
 Posted-price
 Haggling
 Auctions
Equilibrium Price/Quantity
Demand Curve
Demand: how much consumer are willing
and able to buy at different prices
Pepsi Auction
Market Equilibrium
price
At P1: Qd = Qs
The market “clears”
S1
P1
D1
Q1
Note: Quantity Demanded vs Demand
quantity
Demand Shifters
 Preferences
 Population
 Income
 Normal goods
 Inferior goods
If income rises, demand rises
 Substitutes
 Complements
If Px rises, demand for Y rises
If income rises, demand falls
 Price of Related Goods
 Expectations
If Px rises, demand for Y falls
Supply Shifters
Number of firms
Cost of inputs
Technology
Expectations
Market Disequilibrium
Surplus
price
S1
Surplus
At PHi: Qd < Qs
 Pressure on price to fall
Shortage
PHi
P1
PLo
At PLo: Qd > Qs
D1
Shortage
 Pressure on price to rise
Qsd
Q1
Qs Q d
quantity
In the fall of 1903 Ohio Tech students for the first time had to pay
to attend university football games; as a result, every game had many
empty seats. This decline in attendance suggests that:
the demand for football games declined.
attending football games is an inferior good.
attending football games is a normal good.
the quantity demanded of football games fell.
1
2
3
4
5
0%
0%
d)
0%
c)
a)
0%
b)
a)
b)
c)
d)
A newspaper story recently reported that the price of new
cars has increased, and the quantity of new cars sold has
dropped. The price and quantity changes were probably
caused by:
a decrease in buyers' incomes.
an increase in buyers' incomes.
an increase in production costs.
a decrease in production costs.
1
2
3
4
5
0%
0%
d)
0%
c)
a)
0%
b)
a)
b)
c)
d)
Consider the market for computers. Suppose that the price
of plastic decreases and the income of consumers
decreases. What may we conclude about the equilibrium
price and quantity of computers?
a)
price will fall and quantity is
indeterminate.
quantity will rise and price is
indeterminate.
quantity will rise and price will rise.
both price and quantity will be
indeterminate.
b)
c)
d)
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)
Market Efficiency
 Invisible Hand Theorem
 Adam Smith: Wealth of Nations (1776)
 Competitive, free markets will maximize
social welfare
“It is not from the benevolence
of the butcher, the brewer, or the
baker, that we expect our dinner,
but from their regard to their
own interest. We address
ourselves, not to their humanity
but to their self-love, and never
talk to them of our necessities
but of their advantages.”
Consumer Surplus
 Net gain to consumers from
buying at a single price
 CS = Buyer Value - Price
Price
Buyer Values (or WTP)
$50
$25
Consumer Surplus
Market price
Demand
Total Expenditure
1
5
quantity
Producer Surplus
 Net gain to sellers from selling at a
single price
 PS = Price – Seller Cost
Price
$25
Supply
Market price
Producer Surplus
Seller Costs
$10
Total Cost
3
quantity
Which of the following is an example of consumer
surplus?
a)
Bo Yuan buys a hamburger for $2
and tells you she would not have
paid a penny more.
Carrie believes the price she paid
for her computer was too high.
Logan buys a paper tablet for $2
and finds the same good at another
store for $1.50
Cody would have paid $20 for a new
compact disc but paid only $15.
b)
c)
d)
0%
a)
1
2
3
4
5
0%
0%
0%
b)
c)
d)
Social Welfare
Price
Deadweight Loss
Supply
CS
P*
PS
Demand
Q
Q*
quantity
 Free Market Outcome: P*, Q*
 Maximizes social welfare: SW = CS + PS
Garden of Eden
Adam
Eve
12
0
9
3
5
5
4
8
0
12
Tradeoff: Efficiency vs. Equity
Adam and Eve in the Garden of Eden, by Titian (c. 1550)
Supply and Demand Step Functions
70
65
Supply
60
55
50
Price
45
40
35
30
25
20
15
10
Demand
5
0
0
1
2
3
4
5
6
7
8
9
Quantity
10
11
12
13
14
15
16
Chart 3: Price Sequence
45
40
35
30
Price
Session 4
Session 2
25
Session 1
20
Session 3
15
10
5
0
0
10
20
30
40
50
60
70
Contracts
80
90
100
110
120
Government Intervention
 Why does government intervene?
 Market failures
Monopoly
Externalities
Public goods
 Fairness
All generate some DWL
 How does government intervene?
 Price Controls
 Quantity Controls
 Regulations
Price Ceiling: Rent Control
 Free Market: R1, Q1
 Gov’t imposes rent ceiling at R0
At R0: Qd > Qs  shortage
Rent
DWL
RF
 Non-Price Rationing
R1
Black Market (Bribes)
Discrimination
Wait / Search
Lottery
R0




S1
D1
QS
Q1
Shortage
QD
Apartments
Other Examples of Price Ceilings
 Gasoline (1970s)
 Usury laws
 Diagnostic Related Groups (DRGs)
Rapidly increasing health costs have been a major political concern
since at least 1992. Suppose that to control rising health costs the
government sets the maximum price for a normal doctor's visit at $20,
but the current market price is $40. Then:
more people will try to visit the doctor,
but the doctor will see fewer patients.
the same number of people will try to
visit the doctor, and the doctor will see
the same number of patients.
more people will be able to see the
doctor, since the price is lower
fewer people will try to see the doctor,
and the doctors will see fewer patients
d)
a)
0%
1
2
3
4
5
0%
0%
0%
d)
c)
c)
b)
b)
a)
Price Floor: Minimum Wage
 Fair Labor Standards Act (1938)
 1938: $0.25
 2008: $6.55
Federal minimum wage will
rise to $ 7.25 this summer
Ohio’s minimum wage went
up to $7.30 this past January
States with minimum wage rates higher than the Federal rate
States with minimum wage rates the same as the Federal rate
States with minimum wage rates lower than the Federal rate
States with no minimum wage law
Federal Minimum Wage Rate
1950-2009
$11.00
$10.00
minimum wage in
2008 dollars
$9.00
$8.00
$7.00
$6.00
$5.00
$4.00
$3.00
minimum wage in
current dollars
$2.00
$1.00
$0.00
1950
1960
1970
1980
1990
2000
2010
60%
Minimum Wage Relative to the
Average Hourly Wage Rate
1965-2008
50%
40%
30%
20%
10%
0%
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Characteristics of Minimum Wage Workers, 2007
At or Below $5.18
Total
1.7 million
75.9 million
% Employment
2.3%
100%
Gender
Male
Female
31.6
67.8
49.8
50.2
Race
White
Black
Hispanic
Asian
82.1
11.9
14.2
2.9
80.5
13.2
17.4
3.6
Age
16-19
20 +
21.6
78.4
7.1
92.9
Hours of Work
Part-time
Full-time
56.2
43.5
23.7
75.8
Occupation
Sales
Service
13.9
72.2
27.7
22.3
Industry
Retail
Leisure & Hospitality
Manufacturing
8.2
61.2
2.2
14.1
11.2
13.0
Education
Less than HS
HS only
Some college
BA +
24.2
32.7
34.8
8.2
16.1
36.5
32.5
11.7
# Hourly Workers
2009 Poverty Guidelines
(48 Contiguous States and DC)
Persons in Family
Poverty Threshold
1
$10,830
2
$14,570
3
$18,310
4
$22,050
5
$25,790
6
$29,530
7
$33,270
8
$37,010
For families with more than 8 persons, add $3,740 for
each additional person.
Source: http://aspe.hhs.gov/poverty/09poverty.shtml
Labor Market

Free Market: W1, Q1
 no unemployment: QD = QS
(full-time income?)

S1
W2 = $7
Gov’t imposes min. wage at W2
 at W2: QD < QS
 Unemployment occurs

unemployment
Wage
DWL
W1= $6
How can employers offset impact?





Reduce hours of work
Reduce fringe benefits
Raise price
Reduce quality
Hire illegal aliens
D1
QD
B
W
layoffs
Q1
QS
new entrants
Labor
Suppose that the equilibrium wage in the low-skilled labor market is
$8.00. Further, suppose the federal government raises the minimum
wage to $7.25 an hour from its present level of $6.55. The government’s
action of increasing the minimum wage will result in:
a decrease in unemployment
an increase in unemployment
a shortage of low-skilled labor.
neither a shortage nor a surplus of
labor in the low-skilled labor market.
1
2
3
4
5
0%
0%
d)
0%
c)
a)
0%
b)
a)
b)
c)
d)
Taxes
 Sales Tax: percentage of sales
 Excise Tax: fixed dollar amount per unit
Sin Taxes?
Taxes
 Sales Tax: percentage of sales
 Excise Tax: fixed dollar amount per unit
Sin Taxes?
 Buyer Tax vs Seller Tax
 Economic burden does not depend on legal burden
Excise Tax: Cigarettes
 Free market:
 P = $4.00
 Q = 27.4 b
S2
price
S1
buyer pays
 Consumer Spending ≈ $110 b
4.40
4.00
Tax Revenue
tax = $1
3.40
 Gov’t imposes tax = $1/pack
seller keeps
D1
 Supply shifts upward by $1
 Price rises (by less than $1)
 Quantity falls
 Economic burden of tax is split
between buyers and sellers
25.8 27.4
cigarettes
(Billions of packs)
Suppose the government imposes a $10 excise tax on the sale
of sweaters by charging suppliers $10 for each sweater sold.
Based on economic analysis, we would predict that:
a)
The price of sweaters will increase
by $10.
The price of sweaters will increase
by more than $10.
Consumers of sweaters will bear
the entire burden of the tax.
The price of sweaters will increase
by less than $10.
(a) and (c) are true.
b)
c)
d)
e)
1
2
3
4
5
0%
0%
0%
0%
0%
a)
b)
c)
d)
e)
In the figure below, the amount of tax revenue is:
a)
b)
c)
d)
$2000
$4000
$6000
$8000
0%
2000
1
2
3
4
5
0%
0%
4000
6000
0%
8000
Quantity Controls
 Quotas
 International trade: agricultural goods, textiles
 Taxis, liquor licenses
 Prohibition
 What goods and services are illegal to trade?
 Why prohibit trade?
 Victimless crime?
 Immoral?
 Externalities?
Drugs
Prostitution
Body organs
Babies
Guns
Exotic animals
Gambling
War on Drugs
 Intrinsic Effects




Health Damages
Spousal/Family abuse
DUI
Lower worker
productivity
 Black Market Effects
 Crime
 Property
 Murder
 Overdose
 Uncertain product quality
 Binge consumption
 Clogged prisons
 Corruption
 Reduced civil liberties
Alcohol: 125m users-----85,000 annual deaths
Tobacco: 70m users-----400,000 annual deaths
Marijuana: 15m users-----0 annual deaths
Cocaine: 2m users---Heroin: 0.2m users---- 17,000 annual deaths
Tradeoff: Intrinsic Effects v. Black Market Effects
Marijuana Market
 Prohibition: P1, Q1
 Legalization: P2, Q2
S1
price
S2
 Consumption will rise
(how much?)
$200 = P1
Tradeoff:
> More intrinsic costs
> Less black market effects
P2
D1
Q1
Q
2
 What happens in the market for substitutes?
 What happens in the market for complements?
Marijuana
When a government imposes penalties on both sellers and
buyers of an illegal good,
c)
0%
a)
d)
1
2
3
4
5
0%
0%
0%
d)
b)
c)
the price of the good falls as does
the quantity purchased.
the price of the good falls, but the
quantity purchased may increase
or decrease.
the price of the good rises, but
the quantity purchased may
increase or decrease.
the quantity purchased of the
good decreases, but the price may
rise or fall.
b)
a)
"If the DEA intercepts 100 tons of cocaine, the
supply of cocaine will fall. This will cause the price
to rise, which will increase the supply back to its
original position."
True, false, or uncertain. Explain.
Which of the following influences does NOT shift
the supply curve?
a)
b)
an increase in consumer income
a decrease in the price firms
expect to receive in the future
a rise in the wages paid workers
development of new technology
c)
d)
0%
a)
1
2
3
4
5
0%
b)
0%
c)
0%
d)
Market equilibrium is a situation in which:
a)
consumers obtain the highest
quantity at the lowest prices
producers obtain the highest price
for a given quantity sold
quantity supplied equals quantity
demanded at a single price
the market yields a substantial
surplus of goods produced
b)
c)
d)
1
2
3
4
5
0%
a)
0%
b)
0%
c)
0%
d)
The number of people seeking to obtain tickets to an OSU
football game is nearly always larger than the number of
available tickets (and seats) to the game. This is evidence
that the price of the ticket is
4
5
at
ui
...
th
e
h
...
hi
g
o
th
e
to
th
.
3
lo
w
e
2
be
ov
ab
1
0% 0%
...
0% 0%
eq
above the equilibrium level
below the equilibrium level
too high for many to afford
at the equilibrium level because
the number of tickets bought
always equals the number of
tickets for sale.
..
a)
b)
c)
d)
Which of the following statements uses incorrect terminology:
A: "The recent fare war among the major airlines has increased
the demand for air travel.“
B: "The terrorist attack on America has caused the demand for
air travel to fall."
a)
b)
c)
d)
1
A
A
A
A
2
is incorrect; B is correct
is correct; B is incorrect
and B are correct
and B are incorrect
3
4
5
0%
0%
0%
0%
a)
b)
c)
d)
Which of the graphs below best illustrates a situation
in which price will fall?
a)
b)
c)
d)
1
2
The graph on the left
The graph on the right
Both graphs
Neither graph
3
4
5
0%
0%
a)
b)
0% 0%
c)
d)
Between 2002 and 2003 bad weather affected the area where most
of the world’s vanilla is grown. Which of the graphs below best
depicts that situation?
a)
b)
c)
d)
A
B
C
D
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)
After bad weather affected most of the world’s natural
vanilla, which of the graphs below best depicts what
happened in the market for synthetic vanilla?
a)
b)
c)
d)
A
B
C
D
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)
You notice that the price of DVD players falls and the
quantity of DVD players sold increases. This set of
observations can be the result of:
a)
a shift of the demand curve for
DVD players to the right
a shift of the demand curve for
DVD players to the left
a shift of the supply curve of DVD
players to the right
a shift of the supply curve of DVD
players to the left
b)
c)
d)
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)
In 1979 a revolution overthrew the government of Iran, disrupting
oil production and causing the price of crude oil to increase by 300
percent. In most of the world this price increase:
led to severe shortages of gasoline
did not lead to shortages
led to substantial surpluses
did not affect supply or demand
for gasoline substantially
1
2
3
4
5
0%
0%
d)
0%
c)
a)
0%
b)
a)
b)
c)
d)
Most economists believe that the U.S. minimum
wage has relatively little effect because it is set too:
a)
b)
c)
d)
low and therefore is nonbinding
high and therefore is nonbinding
low and therefore is binding
high and therefore is binding
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)
Which of the following is an example of a black
market?
a)
a tenant in a rent controlled
apartment subletting at a higher rent
the purchase of an inferior radio at a
department store
waiting in line during the oil shortages
of the 1970s
none of the above
b)
c)
d)
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)
This figure shows the supply and demand for clams. The
government imposes a quota limiting sales of clams to
8,000 lbs. The quota rent per pound is:
a)
b)
c)
d)
1
$2.00
$4.00
$5.00
$6.00
2
3
4
5
0%
0%
0%
0%
a)
b)
c)
d)
A consumer's willingness to pay for a surfboard is the
minimum price at which he or she would buy the
surfboard
a)
b)
True
False
0%
a)
1
2
3
4
5
0%
b)
To the extent that eBay moves the markets for collectibles
and other items to equilibrium, it can be said to:
a)
maximize consumer
surplus
maximize producer
surplus
maximize total surplus
create a market failure
b)
c)
d)
0%
a)
1
2
3
4
5
0%
0%
b)
c)
0%
d)